AN EMPIRICAL EXAMINATION OF INVESTOR OR DEALER STATUS IN REAL ESTATE SALES

Abstract

The importance of determining whether the seller of real estate is a dealer or investor is of major significance in terms of the income tax consequences of each characterization. That is, an investor may be entitled to capital gain treatment (at a 15% tax rate) on the sale of real estate, whereas a dealer may be subject to ordinary tax treatment (at a 35% tax rate in 2003), based on the particular circumstances. On the other hand, a dealer may be entitled to the benefit of ordinary loss treatment; in contrast, an investor could be limited to a $3,000 capital loss for the year. Naturally, a judicial decision reclassifying a taxpayer from dealer to investor or vice versa can result in costly additions to his or her tax liability.

This study investigates the issue of investor or dealer status in taxation by examining decisions of the Tax Court and U.S. District Courts from 1970 to 2000. Specifically, we build limited-dependent and qualitative variables models (i.e. logistic and probit regression models, and a discriminant analysis model) from the variables delineated in the landmark Winthrop case. Analyzing cases which utilized these factors resulted in a final data set of 87 judicial decisions yielding a total of 96 observations.

The final model from each method retains the same five significant predictor variables. The Hosmer and Lemeshow’s Chi-Square statistics for the probit and logit models are 3.5036 (p-value=0.6229) and 5.7173 (p-value=0.3347), respectively, both of which indicate a good fit. These models each have a proportional Rp2 of 86.5%. The discriminant function, with the same 5 predictors, has a classification accuracy rate of 85.4%. Furthermore, we test all models over a holdout sample of 10 decisions, and predict the outcome of all 10 holdout cases, with no ambivalence, for an accuracy rate of 100%.

Citation

Englebrecht, T.D. and Bundy, T.L. (2004), "AN EMPIRICAL EXAMINATION OF INVESTOR OR DEALER STATUS IN REAL ESTATE SALES", Advances in Taxation (Advances in Taxation, Vol. 16), Emerald Group Publishing Limited, Bingley, pp. 55-72. https://doi.org/10.1016/S1058-7497(04)16003-1